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Home  Passing on the Business, Looking at Your Exit Strategies

Passing on the Business, Looking at Your Exit Strategies

James Mello |

Some business owners are looking to hand down their business to a family member; others may be looking at the option of selling to a hard-working employee. still others may be looking to sell their business to another company in the industry, while some may look to sell to an individual who wants to get into the industry. All of these options are part of the exit strategy process. there are numerous options, and i would like to touch on some of these alternatives.

Leaving or selling the business to a family member

It is the American dream to build a successful business and leave it to a son or daughter. I have seen this happen successfully, but the son or daughter should already be active in the business, and proven that he or she has the ability to continue running it.

The ideal scenario is that the owner has been able to make, save and invest enough money to support his own retirement and can hand down the business with no debt. In many situations, this is not the case and the owner will have to sell, not give, the business to his son or daughter.

Unfortunately, banks have been unwilling to loan money for goodwill, so the only way the son or daughter can get the money to pay off the parent is to bank finance the assets. This will pay for the vehicles, equipment or real estate, but they will still owe for the goodwill.

The other option is for the parent to finance the business and get paid back over time. You have to be sure that the business has the cash flow to allow the son or daughter to be able to make the payments and still have the cash flow to continue running the business successfully.

Putting the son or daughter into debt can potentially create some family problems, especially if business gets slow. Although this is the American dream, it can turn into the American nightmare.

Many great family relationships have been destroyed over business ventures. This can be very risky. One alternative I have recommended is for the parent to sell off a small portion of the business to his son or daughter and sell the majority of the business to another buyer, so the parent can receive his retirement money for the business and yet still allow the family business to continue.

Selling the business to a hard-working employee

This option can be very similar to the family member option as far as the financing is concerned. Most employees do not have the cash to buy your business; if they do, you have either been paying them too much or they have been stealing from you. I see this as a good alternative when the seller cannot get the price that he wants from any other buyer. Usually, the employee will pay more; what does he have to lose?

In this scenario, the seller becomes the bank and holds the note and the title to any assets until the balance is paid off. The seller should stay proactive and have the legal right in the purchase agreement to oversee the books of the business on a constant basis. This will assure that the buyer is running things properly, to protect the seller’s interest until he gets his money out. Usually, long-term payouts—like 10 to 20 years—can give the buyer an opportunity to have enough cash flow to keep the business growing and to be able to satisfy his debt.

I have also seen this work with larger companies, where all the employees become owners, called an Employee Stock Option Plan (ESOP). Every year, a certain amount of ownership is transferred to the employees, but the seller usually stays on board and runs the business. In most cases, the seller retains a certain portion of the stock and stays on as a part owner.

In later years, the seller usually resigns from day-to-day duties but will serve on the board as an advisor. This gives the owner a nice, gradual transition out of the business, while both being paid as an employee and receiving the monies for the goodwill and assets, while retaining stock in the company.

This stock ownership will grow in value as the business grows. But be aware that there is a lot of legal expense initially to get an ESOP properly established. However, there can be rewards, in both a higher purchase price and possible tax savings, as the cash for the business is taken over time.

Selling to an individual not associated with your business

This is the rarest of exit strategies and the one option many sellers hope to find. The son of a rich parent whose daddy will buy him a business, the lottery winner who wants to own his own business, or the college graduate with a trust fund to draw from, would be likely candidates. I call this the fictitious buyer because they just are not out there or are one-in-a-million to find.

People have to be pre-exposed to our industry to be interested in buying a landscape, lawn care or irrigation business, especially if pesticides are involved. Usually, the independent buyer who would be interested in buying a company in our industry would be someone who has been working in the industry, understands it and likes it. The problem again is that the probability of this buyer having the financial resources to buy a company is rare.

With bank financing unavailable, it is possible that the government, through the SBA, will guaranty the note for a bank. The paperwork, and the time it takes to get through the approval process, is long and arduous, even for the most patient and motivated buyer. Many times, these deals fall apart.

This exit option of selling to an individual sounds good, but is rarely successful, except in very small, one-man operations where the purchase price is small and the seller is willing to help train the new buyer.

Selling to a larger competitor

This exit strategy is by far the most common that I see in the industry. Companies looking to grow through acquisitions can increase their revenue, as well as taking a competitor out of their marketplace. In addition to increasing their market share, they can also pick up experienced employees with the purchase of the business. Generally, large established companies have the financial resources to buy another competitor without the seller financing.

This exit strategy can work well, but the seller should do his research on the buyer and be sure that the buyer is a good fit for his business. I have seen infinite variations of pricing, terms and conditions from various larger buyers, so you have to carve out or negotiate the deal that works best for you.

If you are concerned about how your employees and clients will be treated and serviced after the sale, then you need to do your due diligence on the buyer before you make your decision. Don’t be afraid to ask for references from previous companies which that particular buyer has purchased.

When it comes to terms, many companies will have a hold back; you’ll want to be careful with the way the purchase agreement is written so that you’ll receive all of your money. There are a lot of intermediate-size buyers now that are competing with the industry giants for acquisitions, so do your homework when looking for a buyer. You only sell your business once; I stress that you take your time and look at all the alternatives out there.

In conclusion, when considering an exit strategy I suggest that you start the process early, even years before you are really ready to sell. I recommend to all my clients that they go through this process with me and repeat it every three years, so they know what the true value of their business is. This is just part of good estate planning.

God forbid, if something were to happen to you, your heirs would know the value of the business and where to sell it if they had to. I recommend that owners file this appraisal with their important insurance papers for safe keeping.

Going through the process will also teach you what parts of your business are most valuable. You can then adjust your marketing and business direction to increase the value of your business so that when you are ready to exit, you will get the maximum amount of dollars for it.

Preparing for your exit strategy should be an important part of the way you run your business.

My next article will deal with the actual mechanics of the selling process.

EDITOR’S NOTE: James D. Mello is the owner of Professional Business Consultants. He can be reached at 708-744-6715 or pbcmello1@aol.com

 
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